Carbon footprinting: Building ESG metrics into your financial plans [Part 1]
Part 1: Dealing with Scope 1, 2, and 3 emissions
Author: Steve Bows, Certified Master Anaplanner and Managing Director, Zooss Consulting.
Last year I took a year out to do a Masters in Sustainability. I’ve been building planning models for over 25 years (originally in Adaytum — anyone old enough to remember that?), and most of them have been different permutations of financial planning and analysis use cases. As an accountant, this is a comfortable space for me, focussing on profitability and cash flow planning. I’ve also been a keen advocate for environmental conservation, and until recently I hadn’t even considered that I might be able to combine these two worlds.
But a chance meeting with an academic who had conducted pioneering work in sustainability analysis changed all that. He showed me how direct and indirect carbon emissions can be mathematically modeled, and how these approaches can be extended to many other environmental and social metrics. Intrigued, I signed up for the MSust to explore these techniques in more detail.
In a series of three articles, I'll take one ESG use case (carbon footprinting), explain some of the concepts and approaches involved, and how you can incorporate these ideas into Anaplan models.
Scope 1 and 2 emissions
First, some terminology and definitions on the different scopes of carbon emissions. Scope 1 emissions refer to the direct emissions that a company, entity, household, or individual is responsible for. This is the easiest scope to grasp — when we burn natural gas for heating, petrol in our cars, or coking coal to make steel, these produce Scope 1 carbon emissions. Scope 2 emissions are one step removed and refer exclusively to electricity. Electricity is generated from renewable sources (solar, wind, hydro) or by burning fossil fuels (coal and natural gas). Therefore, a percentage of the grid electricity that you consume (as a business or individual) will come from burning fossil fuels. Most governments (you can find the latest Australian figures here) will provide emissions factors for both Scope 1 (e.g., kgCO2e1/litre of petrol burnt) or Scope 2 (e.g., kgCO2e/kWh of electricity consumed). This means, as an Anaplan modeler, you estimate the liters and kWh respectively, and you can project Scope 1 and 2 emissions.
Most companies have worked this part out, and some will go as far as to say that reducing their Scope 1 and 2 emissions to net zero is the entirety of their emissions reduction strategy. Building an Anaplan model that tracks how a company plans to reduce their liters of fuel burnt (e.g., switching the fleet of diesel trucks to hydrogen fuel cell equivalents) or kWhs of grid electricity (e.g., by installing their own solar panels) is easy enough. It turns out that this is scratching the surface because it ignores what is called Scope 3 emissions.
Scope 3 emissions
Scope 3 emissions are often called indirect emissions, or embodied carbon. They represent emissions that have been generated anywhere upstream or downstream in your supply chain, but not directly by your company’s operations. They can range from 50–90% of a company’s total emissions, and they're much harder to abate — because they are harder to control.
If these emissions are hard to control (and hard to measure as well), why should we include them? Don’t they belong to someone else? Well, mainly to avoid gaming the system. Imagine sitting around the boardroom table and discussing the cheapest way to reduce Scope 1 emissions from your truck fleet. You could transition them all to hydrogen fuel cell vehicles (more economical than battery-electric vehicles for heavy vehicles, but still more expensive than the existing fleet), or you could outsource all your logistics to a third party. Problem solved — Scope 1 emissions disappeared overnight! They are now part of your Scope 3 emissions and your company has greenwashed its way to net zero.
This is one of the reasons the ISSB (part of IFRS) is keen to include Scope 3 in its latest exposure draft (a PDF can be found here). As hard as they may be to measure and abate, every listed company will soon have to consider its Scope 3 reduction strategy to go alongside its Scope 1 and Scope 2 plans.
Two approaches to Scope 3
There are two approaches to measuring Scope 3 emissions, and I’ll be describing each of these in more detail in the second and third articles in this series. The first is a bottom-up technique called Life Cycle Assessment (LCA). LCA studies are typically performed by specialist engineers, who analyze every2 stage of a production process — from cradle to grave — and measure the emissions of each of those components. Some are Scope 1, others Scope 2, but they also measure Scope 3 insofar as that is possible. They tend to take a long time, be quite costly, and hence can only cover a small part of a company’s production process. However, they produce incredibly valuable data, and I’ll be talking in article two about how this data can augment an Anaplan production planning model.
LCAs measure the emissions footprint per physical unit of production, which is the closest we can get to a causal or driver-based relationship. However, we can never measure the whole supply chain in this way — it'd be prohibitively expensive — so we need to complete the picture using Input Output Analysis (IOA). This uses mathematical techniques developed in the 1940s to model the interrelationships between different industries in an economy, and allows us to attribute a kgCO2e/$ to all of the other purchases that haven't been addressed by LCA data. We’ll be looking at this in the third article in the series.
When designing an Anaplan model, the first step is breaking your business process down into manageable chunks by asking the right questions. Hopefully, you can start to see how this would apply to building a carbon footprint model. “What are your sources of Scope 1 emissions?” would be a great first question, followed by “can we get estimates of liters (petrol), GJ (natural gas), and kWh (electricity) used in your business, so we can build a driver-based model for Scope 1 and 2 emissions?”
You’re making progress already! See you after the New Year for the next two articles in this series, where I’ll cover the use of Life Cycle Assessment (in Part 2) and Input Output Analysis (in Part 3) for Scope 3 emissions planning.
Do you have questions about carbon footprinting and the different scopes of emissions? Leave a comment!
1. kgCO2e is ‘kilograms of Carbon Dioxide equivalent’, the standard unit of carbon footprint measurement, reflecting the fact that it is not just Carbon Dioxide that causes global warming.↩
2. Some LCA studies will restrict themselves to a portion of this life cycle, eg Cradle-to-Gate (upstream supply chain) or Gate-to-Grave (downstream supply chain) depending on where the problem areas are most likely to be.↩
Just trying to get a handle on how to record and report is challenging enough without then going how to reduce especially in FS which may have potentially limited 1 & 2 but massive 3 because of where investments are and who customers are. And then there's scope 4... 🤯0
Absolutely @andrewtye ! its a two-step process - get your data sorted out first before you try to plan with it. And yes, Scope 3 is a big challenge, but its not going to go away if we ignore it 🙈. I'd be interested in your thoughts on using Input Output Analysis (see part 3, coming soon!) for estimation0
@ahenry Look for part 2 next week!2
@ahenry yes @GingerAnderson beat me to it - Part 2 is coming next week. I think you'll like it, some thought-provoking stuff on how you can integrate 'bottom-up' carbon footprinting into supply chain models. Part 3 is scheduled for end of Feb. Please reach out if you want to discuss - its an evolving field with few right/wrong answers!1